Welcome to Spotify's 2019 financial results question and answer session. A copy of the company's shareholder letter, issued pre-market open today, is available on the investor relations website, investors.spotify.com. This call is being recorded and an archive replay will be available on the IR site after the event concludes. I will now turn the call over to Paul Vogel, Head of Investor Relations and FP&A. You may now begin your conference.
Great. Thank you, welcome to Spotify's first quarter 2019 earnings conference call. With us today are Daniel Ek, Spotify CEO, and Barry McCarthy, Spotify CFO. First, I want to thank everyone for joining us this morning. We know it's a bit unconventional to do an earnings call pre-market on a Monday, we appreciate everyone making the time to be with us this morning. The format of today's call will be similar to prior quarters. Daniel will give a few brief opening remarks, followed by an online question and answer session. Questions can be submitted either through the widget alongside the webcast or by emailing directly to ir@spotify.com. We'll get to as many questions as we can. The call will last approximately 30 minutes. Before we begin, let me quickly cover the safe harbor.
During this call, we will make forward-looking statements, including projections or estimates about the future performance of the company. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could materially differ because of factors discussed on today's call and in our letter to shareholders and filings with the Securities and Exchange Commission. During this call, we refer to certain non-IFRS financial measures. Reconciliations between our IFRS and non-IFRS financial measures can be found in our letter to shareholders, on the financial section of the investor relations page of our website, and also furnished today on Form 6-K. With that, I'll turn it over to Daniel.
All right. Thanks, Paul, and thanks, of course, everyone for joining today's call. We had a very strong quarter as most of our key metrics were at the high end or exceeded the top end of our forecast. In the quarter, we closed the previously announced acquisitions of Gimlet and Anchor, and in April, the recently announced deal for Parcast, three best-in-class podcasting companies. These deals will help accelerate our goal of becoming the world's number one audio platform. We're also excited to share that we've reached 100 million premium members. This is an important milestone in our mission to connect over one billion users with billions of artists. We launched in India, and in the first quarter, and we're really pleased with the results there. We got more than two million users on Spotify today in India.
Looking more broadly at the global music economy, it was really encouraging to see that the 2018 industry data shown strong growth across the music industry, led almost entirely by streaming, which accounted for 47% of all recorded music revenue. With physical and download revenue in decline, the 34% year-over-year growth in streaming is the engine driving the train, and Spotify continues to be the driving force that has made the music a growth industry again. Related to this, the number of creators that are engaging directly with Spotify's platform continues to increase, growing to over 3.9 million this quarter. We're also seeing a significant growth in the discovery of new artists on Spotify. In Q1, we saw a 20% increase in the number of artists streamed on our platform year-over-year, and a 29% increase in the number of artists with at least 100,000 listeners.
We believe this engagement from artists, labels, and publishers shows a strong sign that there's an increased appetite for more marketplace tools and services. With more than 60 million tracks now available on Spotify and growing by close to 40,000 daily, the discover tools we're building has never been more important to consumers and artists alike. Overall, we feel really good about our first quarter results and remain very optimistic about the rest of the year and our long-term opportunity to become the world's largest global streaming audio company. With that, let's open the floor for questions.
Great. Thanks, Daniel. Our first question comes from Ross Sandler at Barclays. "Connected speakers have been a nice tailwind for growth over the past few years. Do you think that changes for Spotify if the larger platform owners introduce new services like ad-supported streaming, or do you think those channels continue to be accretive for growth rates? Any thoughts on Amazon's recent move, and how should we think about voice in general?
Well, we believe voice really across all platforms are a critical area of growth, particularly for music and audio content, and we're investing in it, and we're testing ways to explore and refine our offering in this arena. One of the core pillars of our strategy, of course, is ubiquity, so we want to be on all major platforms that you can imagine. The only thing I would kind of say is, while the growth rate of voice speakers is impressive, it's still very small when you compare it to mobile.
Our next question comes from Matthew Thornton at SunTrust. In terms of music content cost, any update or color management can offer as the timeline of negotiation to deal with the labels, the appeal of the CRB ruling, and the DOJ review of the consent decrees?
Well, as we've said before, the results of our renegotiations with the labels, the key pillar here is to drive the adoption of our marketplace strategy. That is the future for our margin growth. It's not about renegotiation of the deals. We're doing really well in terms of the build-out of the marketplace tools. We're doing really well with the music industry in the adoption and testing of those tools. That's what I can share at this moment.
Sorry, let me just jump in on the CRB timeline, that will be a long, drawn-out process. It's the nature of the beast.
Our next question comes from Eric Sheridan at UBS. On advertising, can you provide more detail on the ad pricing commentary from the earnings release? What happened and what was corrected in the go-to-market approach, and how should it impact future periods starting in Q2? Second part, how would you contrast frame the North America versus global ad opportunity on the platform?
Part one of the question, the softness we saw in the quarter, primarily in the U.S. business, was related to Sponsored Sessions, which had been using performance pricing, which worked extremely well in Q3 and Q4 in high-demand periods. Prices out of the marketplace in a slow demand period in Q1, and we were slow to react and adjust our pricing, which we did in the third month of the quarter, but too late to fix the revenue shortfall. In any event, as I said in the commentary, the fix is in, and we're seeing strong revenue growth in Q2. I'm relatively optimistic about that. As it relates to the second part of the question, U.S. versus rest of world revenue opportunity.
The U.S. is a large percentage of the ad revenue base, so at least in today's world, as goes the U.S., so goes the overall performance of the ad business. As we continue to grow in new markets and in Asia and in India, there will be some challenges in keeping pace with the growth from a revenue perspective because those markets just simply don't have as developed an ad market as we have here in the U.S. Secondly, at least initially, our reach in those markets, it will be relatively small until we build critical mass. Until we build critical mass and ad reach, the attractiveness of the platform to advertisers is relatively limited, which was true in the United States as well. We will grow into the demand.
Great. The next question comes from Mark Mahaney at Instinet. You talked about better-than-planned promotions in the U.S. and Canada. Was there anything new you tried, whether it was a new acquisition channel or shifting ad budgets, or was the strategy the same but perhaps more effective?
It was strong across the promotional base. Sometimes some quarters, you have the wind at your back, and we had the wind at our back this quarter.
Next question comes from Doug Anmuth at J.P. Morgan. Can you help us understand the structure and economics of the Samsung partnership and how it shows up in Spotify financials?
It's really a distribution partnership across the board. Samsung's main premise is obviously improving their product. Our main promise is, of course, bringing more music to more products. It's a natural partnership. In terms of economics, I don't really have anything to share.
Yeah, we don't talk about the specifics of any of our deals from a financial perspective. Our next question comes from Anthony DiClemente at Evercore. If ARPU declines are moderating, does that mean mix shift to family plans, student plans is getting into the later innings?
Well, it means that we launched them a year ago, and so we're a year in. Because we're lapping the launch of the plan, it has mathematically less of an impact on ARPU than it's had historically. Now the go-forward influence will have much to do with the geographic expansion of the business and not at all related to the rollout of the family plan, student plan, which is done.
Next question comes from Justin Patterson at Raymond James. More companies are investing in competing podcast products. How has that changed content acquisition costs and the bid-ask spreads in deals you evaluate? How do you feel about your competitive position?
Well, first and foremost, I think that there's a lot of podcast players out there, and that's certainly been true for quite some time. I think last time I checked on the App Store, there were more than 60 or 70 of them. The truth is, while it's not that difficult to build a podcast player, it doesn't mean that it will be successful. As we've seen before on the App Store, it is really very much a top-of-the-pyramid game where there are a few apps that have the majority of the traffic, and we happen to be one of those apps. As we're looking at building this out, I think it's way too early to talk about pricing of deals. This is a very, very early market that we're seeing.
Our view obviously is that while users are starting to flock to listening to podcasts, there's still tremendous amounts of growth both in the U.S. and internationally on the demand side and on the supply side. We don't think yet that the best talent has come to the podcast format and see stronger and stronger growth on that side as well.
Next question related comes from Benjamin Swinburne at Morgan Stanley. Daniel, how would you assess Spotify's ability to curate and help users find podcasts they will enjoy? Is improving this non-music engagement a priority for the company?
Yeah, it's definitely a priority. Personalization is one of our core pillars of our strategy. We are obviously really, really far along in music. Podcast is a much newer space for us. The way we merchandise podcasts, the way we recommend podcasts is completely different. We are working on that and improving quarter-over-quarter. I think you can see already today in the product compared to last quarter that there's a tremendous amount of new things that are shipping. I think I went, in all honesty, from being an okay product at the beginning of 2018 to now, a year later, being best-in-class in this area. Of course, we want to expand on that and become an even better experience. In there, personalization is absolutely key. We think that we're still in the early innings.
Next question comes from Heath Terry at Goldman Sachs. You took steps with regulators to address what you see as anti-competitive issues with Apple. What responses have you seen from regulators to date? What do you see as being the right outcome of this process?
Well, as everyone knows, we filed our complaints with the European Commission. We cannot yet say what the response will be because it's really under evaluation on their end. We will probably know at the same time as the rest of the market knows. What I can say personally from speaking to lots of regulators in and around that time, I do think that this is the moment where these issues need to be debated. I think that there's a willingness to engage on these questions.
I would say lastly, while all that is pending, we continue to remain focused on winning in the marketplace.
Next question comes from Rich Greenfield at BTIG. On Google, what are the key takeaways from the Home Mini partnership, especially in light of its expansion? Did it drive faster uptake of family plans? How is consumption impacted in homes with or without Google devices? Simply put, what drove your desire to expand the partnership?
Well, we saw strong growth in Q4, that led to the expansion of the partnership. In Q1, we didn't grow as fast as we were expecting because of some inventory shortages in the markets where we launched, which resolved itself later in the quarter. Overall, we think that promotional program has been quite effective for us. It accomplishes the strategic objective of expanding into voice-enabled products, it drives user growth. We like the lifetime value.
Next question comes from Lloyd Walmsley at Deutsche Bank. Can you help us understand why the MAU number came in below the midpoint of the guide? To what extent is that weaker new MAUs versus attrition in older MAUs? Are some of the deals you're doing like Google Home, Hulu bundling, and Samsung effectively increasing the pace of conversion from MAU to subscribers?
Yeah, we think there's really not much news with that MAU. We're mostly in the upper end of the range that we guided to, I think we came in at 217. I think the street was at 218. Sometimes rounding helps you, sometimes rounding hurts you. This was one of those quarters where we fell short, it's of no consequence.
Next question is from Nick Delfas at Redburn. You've increased the number of artists on editorial playlists by 30% and number of songs discovered by 35%. Over what time period, and what effect has this had on the three majors' market share?
We don't break out the numbers of any of our rights holders. What I can say, and just to up-level the conversation as well, personalization is one of the core pillars of our strategy. What we see is the user satisfaction is closely related to discovery. If we're able to get customers to discover or rediscover content on Spotify, it drives a better user experience and better engagement, which of course leads to lower SAC, which of course leads to lower churn and higher lifetime value. It's really the same strategy that we apply to podcasts. You should think about our podcasting strategy in the same way. If we have podcast content, it increases engagement through discovery, which leads to lower SAC, lower churn, and then higher lifetime value. It's a repeat and rinse strategy.
The next question comes from Matthew Harrington at Buckingham. Any more thoughts on how Article 17, formerly Article 13, could help Spotify to constrain free YouTube music video usage in Europe?
I think it's really too early to say what the exact impact will be of Article 13 or 17, depending on which revision you're looking at. Now, our view is obviously that we want a landscape where we're competing on a level playing field, and where our rights holders are getting paid for their content. If Article 13 or 17 leads to more of that, we think we will do better. The question is how material is it, and I think it's way too early to say.
Next question comes from Sumant Wahi at Fidelity. How are India subs growing? Why does your ARPU decline low single digits given geo mix shift to lower ARPU geographies?
Two parts. One is we're pretty excited about the growth in India. It's faster than we were initially expecting. Two, price points in India are significantly lower than they are in the U.S., and that's true in Asia as well. If on day one we had zero and on day two we had lots, the day two average company ARPU will be lower than it was on day zero. Margins across regions, independent of price points, are relatively equal. From a margin perspective, the expansion in those regions works for the business, which is why we launched there.
Next question comes from Maria Ripps at Canaccord. We expect to see Spotify evolving different subscription plans. Can you comment on how has the Duo plan been received so far, and when we might expect to see the plan launch in the U.S. and other markets?
Well, just to level set with everyone, we piloted a premium plan called Premium Duo. It's really built for two people living under the same roof. We tested this in five markets, which is Colombia, Chile, Denmark, Ireland, and Poland. We're still early, but we're really encouraged by the early response, and we believe it's going to be accretive to our MAU and sub number if we roll out this more widely.
Next question from Amy Yong at Macquarie. There seems to be increased competition with Amazon looking to launch a subscription-based service and Apple bundling music and video. How are you prepared to face this?
I just think, again, competition is something that I've experienced really throughout the entire life of the company. It started back in the day with Myspace and Lala and a bunch of different competitors. Even back then, Apple obviously had iTunes, and Amazon had a cloud locker service, and Google had not only YouTube, but a bunch of different streaming services. The point I'm trying to make is we've always had competition. Competition's always come in the form of much larger player. That's not unusual to us. Yet we keep on doing what we said we were going to do and keep on growing at more than 30% per year. The point with that, I think, is that the music industry market is just way bigger than most people realize. There are billions of customers out there in the world that are consuming music today.
Most of them are yet not in streaming. We are all, of course, trying to get the music industry into streaming. That is a secular trend that will keep going for at least another five to 10 years. Competition is just not a big factor for us. It's really all about growth.
Next question comes from Michael Morris at Guggenheim. Did minimum guarantees to record labels for newer market launches, including India, negatively impact gross margins in Q1? If so, can you help quantify the impact and how long a drag it will be?
Yes, it did. We won't quantify it. In every market where we launch, including the U.S. when we first launched, there are minimum guarantees that are paid. We initially lose money in those markets. We grow our way into the MAU to break even, and then eventually, to profitability. This is history repeating itself. As long as we are able to achieve the growth objectives we set for the business, and we have consistently, then the markets where we are growing the business become profitable.
The next question comes from John Egbert at Stifel. Your letter discusses your ambition to develop a more robust advertising solution for podcasts. We've seen after the Luminary launch that some top podcast creators can be sensitive about where they host their content. When you speak to top podcast creators who we don't have an exclusive relationship with, what is their acceptance to Spotify potentially selling incremental ad spots on their content, and how do you feel about the analytics they're able to see from listening on your platform?
Well, just to level set with everyone, this is certainly still in the early innings, this whole space. We see a tremendous reaction from the community of podcasters, both now in the recently rolled-out tools, Spotify for Podcasters, where for the first time, really, podcasters are getting actionable insights into who's listening to their content. Most of the cases before, it ended up being regionally, they could see that maybe there was someone in Russia or maybe there was someone in Spain that was listening to their content, but they really didn't have more actionable detail. Because Spotify is a logged-in environment where we do have demographic data, we can share that. It's been very well received by the podcasting community.
When it comes to monetization, it is true that a lot of podcasters are struggling and have to set up their own sales forces in order to succeed creating revenue for themselves. We look at that long-term as a massive opportunity, podcasters are eager for us to get into the space. I think advertisers alike is very eager for us to get into the space with all of the measurability tools and all the things that we're bringing to the industry.
Let me add that Apple, of course, has historically been the largest player in the podcast space. They don't have an advertising business, and there's been no innovation in podcast advertising in its entire history, ads get baked into RSS feeds and delivered to all listeners, regardless of their interest in, or their demographic profile in any particular interest in any particular ad. We're working hard on building digital ad insertion technology, and we'll use that technology to dramatically revolutionize the ad experience on podcasts for listeners.
Next question comes from Brian Russo at Credit Suisse. So far, your podcasting investment seems focused on English language content. Can you talk about how you plan to benefit from your podcasting strategy in parts of the world that do not speak English?
Well, our podcasting initiative is very much a global initiative. As pointed out, I think in our release. We had more than 15 shows that were exclusive to Spotify in Q1. Of those, I think around half of them ended up being international ones, including in Poland and in the Nordics. While our acquisitions have been focused on English language content, I don't think you should read in too much to the fact that that's an English-only strategy. It's very much a global strategy.
Next question goes to Robert Coolbrith from Wells Fargo. Can you comment on churn? Why are you no longer seeing improvement in the churn rate? Are you still seeing churn rate improvements with newer user cohorts? Do you expect improvement in overall churn rate to resume at some point in 2019?
I think the long-term trend for churn will continue to be downward. Family plans, student plan have had lower churn. If you continue to see strong growth in those plans, we'd expect the average churn to decrease, due to aging in the base. The couple reasons for an increase in churn would be acceleration in growth. We saw an acceleration in growth this quarter versus the prior quarter. Secondly, we, in some of our newer markets, have gravitated towards shorter subscription plans. We're experimenting with weekly and daily, by way of example, which may cause us over time to rethink the definition of subscription. We see people coming in and out quickly. One last comment. This is particularly important. In the latest quarter, we saw a dramatic increase in the number of rejoins.
42% of gross adds in the quarter were previous users of the service, which means that more and more frequently, we're seeing former users come back and rejoin. Now some of them may have left because their prepaid debit card expired. It looked like churn, but they re-up the card and came back. Some are coming back just simply because it's a better service. Just to put that in perspective, the rejoin rate grew at 36% year-over-year, which is more than twice the rate year-over-year in growth additions. Yeah, churn ticked up slightly, but more and more previous users are coming back, which will be an important contributor to growth.
I'll just add one other thing. We did mention on the Q4 call, that given the number of subscribers that came in the holiday period of Q4, as well as the uncertainty about how the Google Home campaign would go, that we did expect a slightly higher seasonal uptick in churn than we normally experience. It was actually a little bit better than expected on both of those fronts.
We have a slightly higher mix of 30-day promotions and 60-day promotions. Some of those, if it's been 60 days instead of 30, we've seen it decline in the churn rate.
Follow-up question from Benjamin Swinburne at Morgan Stanley. "Can you earn economic rent from podcasts you distribute but are produced and owned by competitors? In other words, where will the value accrue longer term: the podcast network producer or the podcast distributor?
Well, again, just to kind of level set, we're early in this space and the evolution of this space. Historically, however, on the internet, charging for distribution has been a very difficult business model. I would think that would be very unlikely. Now, our strategy in general is our marketplace strategy, where we want to build better and better tools for creators to connect with users. We definitely think that the same marketplace tools and services that we're building out can be applied to podcasters as well, that's an opportunity, even on content that we do not own.
I would add from 40,000 feet, historically, what we've seen is the gross margin flows to whoever owns demand creation. If you're the NFL, you don't need direct PPV. You're going to own that margin wherever you get distributed. On the other hand, if you're one of now 500,000 podcasts going to 2 million podcasts, if we're able to own the consumer insights that inform us about where the demand is for that content, the margin will flow to Spotify.
We have time for just a couple more questions. The next question comes from Robert Elia from Malone Partners. "Given your focus on being a leading player in audio-related media, how are you thinking about audiobooks?
Right now, we're focused on podcasts. I think when you look at podcasts, however, the distinction of what is a podcast and what is an audiobook remains fairly opaque to us. As an example, one of the categories that has to do really, really well in podcasting, that we're now a major player in, is true crime. What are true crime podcasts? I would say that they're very similar to audiobooks in that they're scripted content, episodic, almost like chapters in a story. I think that the definition of what is an audiobook, what is a podcast, will more and more start blending, and we're going to see new formats at the end of this journey. That exciting factor for me, certainly as I look into and talk to podcast creators, is just all the content and all the new innovation that's coming out there.
Next question comes from Richard Kramer: guidance implies a large increase in cost/decline in gross margin in the second half of 2019. Can you break that down to spending on content podcasts, the impact on expected changes in licensing or other costs which scale with business growth?
Yeah. What we said previously is that if we weren't expanding in podcasts, you'd see margins remain steady. None of the erosion in podcasts relates to our expectations for label renewals. We see that as steady as you go, at least in 2019, and then as we grow marketplace-related services, we'd expect to see margin improvements. All the deterioration relates to a combination of geographic expansion, in markets like India and the payment of minimum guarantees and, very importantly, increased investment in becoming a leading player in the podcast space.
Next question comes from Justin Patterson at Raymond James: Is Hulu's international expansion an opportunity for Spotify? With Disney evolving its strategy for its streaming brand, how is the Hulu relationship changing?
We have a great partnership with Hulu. We're really excited about the prospect of them starting their service internationally, and we're obviously in discussions with them and a number of other partners to see if we can help them support their growth.
We'll take our last question from Paul de Hagnell: How will the absence of two major labels in India impact your growth capabilities there?
Well, I think as evidenced by our growth, we're doing quite okay, and it's above expectations, so we're happy with the growth that we're seeing. Obviously, as before, the more content we can get on the platform is typically going to lead to even faster growth.
Great. With that, everyone, we appreciate your time, and we look forward to speaking with you on our second quarter call in a couple of months. Thanks, everybody.
This concludes today's conference call. You may now disconnect.